Friday, March 17, 2017

No Luck in Alpha Land?

Bill Ackman was used to the question: how could he stick with a loser like Valeant?

But here it was again, this time over lunch with investors and bankers in London on Feb. 28. And there was Ackman, defending a signature investment that, on paper, had cost his clients billions. Yes, Valeant’s share price had cratered. But he insisted to attendees that the drug company’s turnaround prospects were bright, according to people with knowledge of the meeting.

So much for that. Ackman had spent the better half of two years trying to convince just about anyone he was right about Valeant. On Monday evening, just two weeks after that bullish lunch arranged by investment bank Jefferies Group, he conceded what most on Wall Street already believed: In fact, he’d been spectacularly wrong.

News that his Pershing Square Capital Management fund had sold its entire stake at a monumental loss was greeted with equal parts shock and relish. Plenty of investors got burned by Valeant Pharmaceuticals International Inc., which once seemed as if it could revolutionize the drug industry. But no one lost bigger than billionaire investor Ackman, who bought high and sold low, leaping to the company’s defense time and again in a futile attempt to persuade the world his bet would pay off. He held on, even as redemptions at his firm mounted into the hundreds of millions in the final months of last year.

Investor Withdrawals

In finally selling, the firm lost more than $4 billion, according to Bloomberg calculations based on public filings. Jefferies offered Pershing’s entire holding to the market, pricing the shares at just $11.10 a piece, according to a person with knowledge of the matter, who asked not to be identified because the details aren’t public.

Ackman must now contain the damage. With investor withdrawals piling up, Ackman was presented with a stark choice: hold on to Valeant, or surrender to refocus on other, potentially lucrative investments.

Ultimately Ackman acknowledged to the world that the headache of Valeant wasn’t worth it any more. Pershing Square said in a statement on the exit Monday that the diminished-value holding was sucking up too much time and resources.

Now the hedge fund will also have to try and stem withdrawals. It saw about $600 million in redemptions in the final three months of last year, according to data compiled by Bloomberg. In all of 2016, withdrawals totaled more than $1 billion. Those figures don’t include redemptions that have been requested but are still pending, as it generally takes investors two-to-three years to redeem from the funds.

Passionate, Dispassionate

To some, the Valeant saga — and Ackman’s journey in it — is an example of one of the most challenging parts of investing.

“To be a great investor you have to strike a balance between being passionate and being dispassionate at the same time,” Jonathan Grabel, chief investment officer for the Public Employees Retirement Association of New Mexico, said by phone. “It’s a difficult thing to strike that balance.”

The New Mexico pension was among those that redeemed last year from Pershing Square, due in part to the hedge fund’s long lock-up period — which would’ve kept New Mexico committed for another two years, he said.

Pershing Square initially bought Valeant shares in February and March 2015 at an average price of $196.72, according to filings. Within months of Pershing Square’s investment, Valeant was embroiled in controversies that caused a collapse in the shares. Ackman and colleague Stephen Fraidin joined the board a year ago, vowing a turnaround to salvage their investment. Top management was replaced, debts were renegotiated, and about $8 billion in non-core assets were put up for sale.

As the stock declined, the hedge fund continued to double down. But instead of buying shares outright, Pershing Square began relying on a combination of put and call options that increased its exposure while minimizing additional capital outlays.

Target, Herbalife

By Monday, Valeant was at about $11 a share, and Pershing’s losses from its stock and options contracts exceeded $4 billion, filings show. Ackman discussed his actions with Valeant’s management beforehand, a spokesman for the drug company said in an email Tuesday.

Having to acknowledge a big bet gone bad isn’t unknown territory for Ackman. The Valeant exit follows earlier high-profile losses in retailers J.C. Penney Co. and Target Corp. He has also amassed losses in an ongoing short battle over nutrition products group Herbalife Ltd. Pershing Square, which usually holds about 10 positions, has made billions investing in big winners such as General Growth Properties Inc. and Restaurant Brands International Inc. It recently — and profitably — exited investments in railroad holding Canadian Pacific Railway Ltd. and animal-health company Zoetis Inc. The hedge fund has two new as-yet unidentified holdings.

Mark Baak, director at Privium Fund Management, which has an investment in Pershing’s listed fund, said that it was worthwhile to exit because Valeant “probably dominated all the conversations” with clients.

“It’s a better use of his time just to drop it,” Baak said.

Valeant may go down in history as a stock that tarnished the reputation of a number of prominent investors. In addition to Ackman, hedge fund manager John Paulson and managers of the Sequoia Fund, a storied mutual fund started by a friend of Warren Buffett’s, saw billions of gains evaporate in 2015 and 2016 on a business they believed had found a new model for a drug company. Activist ValueAct Capital Management remains one of Valeant’s biggest holders after first investing in mid-2006 in what was then a small experimental-drug developer.

Short Seller

Many investors were seduced by former Chief Executive Officer Michael Pearson’s notion that he could buy drug companies, slash their research and development budgets, and keep getting bigger through acquisitions. It worked wonderfully, until it didn’t.

Some top investors saw it coming — and warned him. While Ackman was researching a potential transaction in the drug company, he asked Jim Chanos — the short-seller who predicted the fall of Enron Inc. and had also bet against Valeant — for his thoughts on the company, and in return received a 26-page analysis. Ackman later denounced Chanos’s short thesis on CNBC.

Pershing Square had embroiled itself in Valeant a year before it invested, teaming up with the drugmaker in a hostile bid for Allergan Plc. That effort failed, triggering lawsuits — and Ackman’s appetite for Valeant’s prospects.

At one point, Valeant was described as “a house of cards” by one of its own bankers, prior to being hired, in an email that was leaked by Allergan during that corporate clash.

Ackman is an investor of extremes, said John Hempton, chief investment officer of Bronte Capital Management, who started wagering against Valeant before it peaked.“When he’s good, he’s really, really, really good,” said Hempton. “And when he’s bad he’s really, really, really bad.”

I'll tell you, the luck of the Irish hasn't been with Bill Ackman ever since he invested a huge stake in Valeant. And John Hempton is partially right, when he's good, Ackman is really good but when he's bad, he's really, really, "really to the power of n!" bad!

Will Valeant (VRX) turn out to be the Canadian pharmaceutical equivalent of Nortel? Who knows and to be fair to Ackman, plenty of other high profile investors have invested in it and some of them recently increased their stake while others, like Bill Miller, have been parading on CNBC claiming the stock will double so "the lowest average price wins" even as shares subsequently hit new 52-week lows (click on image):

There is a word for a weekly chart like the one above: "UGLY". I've been warning my readers not to touch this high profile stock because it's increasingly looking like a terminal short.

We'll see now that Ackman is gone if shares will start rising again but honestly, there are so many BETTER large and especially small biotech opportunities out there, why waste your time hoping this dog will double from here and risk losing it all?

Anyway, enough on "baby" Buffett and Valeant. Anyone who manages an institutional portfolio and takes super concentrated risk on tens of billions is asking for trouble. Only Buffett has managed to do it well consistently over decades but even he has more than ten positions in his portfolio!

[Note: I take very concentrated positions in my personal portfolio and have suffered the joys and extreme pain of such concentration risk, but that is different from managing other people's money.]

Steven A. Cohen got rich by going with his gut on big trades. Now the billionaire trader is experimenting with another path: automating the decisions of his best money managers.

Cohen’s Point72 Asset Management, which oversees his $11 billion fortune, is parsing troves of data from its portfolio managers and testing models that mimic their trades, according to people familiar with the matter.

The wave of automation that’s sweeping finance, initially relegated to taking over mundane tasks, is starting to encroach the ranks of prized money managers who are among the industry’s highest paid. Cohen is pursuing this effort after producing his second-worst year as a trader and as he prepares to return to the hedge fund industry at a time of intense investor pressure on fees.

Unabashed in his view that the industry is short of talent, Cohen has ramped up the project over the past year or so, said the people, who asked not to be named discussing internal matters.

I don't know, this new "cutting edge" data analytics/ automation/ codification sweeping the hedge fund industry makes sense at one level but I'm highly skeptical on many levels of hedge fund quants taking over the world (they will only cannibalize each other in doing so).

At the end of the day, it goes back to what Ray Dalio told me a long time ago when we met: "what's your track record?" (lately, it's been much better than Bridgewater's but not on a risk-adjusted basis , lol).

Show me the beef, stop leaking news to the media of how you're automating your top traders, I couldn't care less and most investors don't care too. They want to see consistent results and a sound process that makes sense and isn't overly complicated.

What else do investors want? Alignment of interests. They are tired of marketing fluff and lame excuses as to why some of their hedge funds charging 2 & 20 or more are delivering mediocre results.

The best advice I can give all hedge fund managers in this tough environment: just be honest with your institutional clients even if it costs you assets. Don't pull the wool over their eyes, just be upfront as to why you're not delivering the goods.

When you do due diligence on a hedge fund, you need to go above an beyond the standard cookie cutter questions available in books and AIMA's due diligence questionnaire. Not just for operations, but for investment and risk management risks.

It's ok to ask your hedge fund manager very tough questions, to grill them no matter how rich and powerful they are. That's the job of an institutional manager investing billions into hedge funds and other alternative funds.

Of course, to do this, you need to access the top managers at these funds and be confident enough to grill them properly. You need to really know your stuff and understand the risks of their positions and overall portfolio.

And it's not just hedge funds. The same thing is going on in private equity where there's a mountain of dry powder and the market return differential over public markets is narrowing:

Private equity firms had as much as $1.47 trillion in funds available to invest at the end of 2016, and debt capital was also readily available to bolster their investments. Still, a situation of rising asset prices, together with fierce competition for these assets in an environment overcast with a possibility of an upcoming recession that could drive down prices, made it difficult to close deals, according to an annual global private equity report from Bain & Company. These firms are cautious about whether today’s deals will bring them to their targeted returns. Banks are also wary of financing big deals.

According to Hugh MacArthur, head of global private equity with the Boston management consulting firm, “Capital superabundance and the tide of recent exits drove dry powder to yet another record high in 2016. Shadow capital in the form of co-investment and co-sponsorship could add another 15% to 20% to that number. While caution about interest rates remains, there is a general expectation that debt will remain affordable. As a result, deals won’t be getting any cheaper.”

Investors continued to show interest in private equity in 2016, and these firms raised $589 billion globally, just 2% shy of the 2015 total. One 2016 trend to note is the rise in “megabuyout” funds that raised more than $5 billion each, with 11 such funds raising a total of $90 billion. These funds appear particularly appealing to institutional investors who want to deploy large amounts of money into private equity, the management consulting firm reports.

And an overall decline in the net asset values of buyout firms, as their distributions to investors outpaced their new investments plus the value of their existing holdings, meant that some investors found themselves short of their targeted private equity allocation. For instance, the Washington State Investment Board pension fund found its private equity allocation down to 21% in 2016, from 26% in 2012. This created a positive environment for private equity fundraising in 2016, but the industry is apprehensive that this strong pace cannot last for too long, as a recession and a stalling stock market, for instance, could upset the strong dynamics.

The buyout market started off slow in 2016, as the Chinese stock market bust, declining oil prices and the uncertainty regarding Brexit in Europe all had an impact. In North America, the market did not recover momentum and the total number of deals for the year was down 24%, with deal value off 16%. In Europe, there was a more moderate drop off.

Bain finds that there is a potential for almost 800 public companies to be taken private in buyouts, but expects a much lower level of actual public-to-private buyouts going by historical activity. While returns on private equity buyouts continue to outshine the returns on public markets, the gap is closing, as it is getting harder for private equity to find outsize returns on undervalued assets in today’s more benign economic environment.

Private equity investors have also settled into longer holding periods of about five years for their investments, and this state of affairs is likely to endure for the near term. Historically, these firms have held on to assets for three to five years, but this period was pushed up in the aftermath of the financial crisis as firms had to nurse their assets over a slow recovery period, the management consulting firm reports.

In fact, deals that private equity firms were able to quickly flip over, holding onto them for less than three years, made up a mere 18% of private equity buyouts in 2016, compared to a 44% share in 2008.

I recently had a chance to talk to Réal Desrochers, the head of CalPERS's PE program, and he told me he was concerned about the wall of money coming into private equity from super large sovereign wealth funds, many of which aren't staffed adequately but just write "huge cheques" to private equity funds (and hedge funds).

It's a recipe for disaster and it all reminds me of what Tom Barrack said in October 2005 when he cashed out before the crisis hit:

"There's too much money chasing too few good deals, with too much debt and too few brains." The amateurs are going to get trampled, he explains, taking seasoned horsemen, who should get off the turf, down with them. Says Barrack: "That's why I'm getting out."

Every large and small institutional investor playing the cheque writing game should post this quote in their office along with my favorite market quote by Gary Shilling often attributed to Keynes: "The market can stay irrational longer than you can stay solvent."

On that note, I remind all you big institutional investors paying 2&20 for beta or sub-beta returns and even you large hedge funds and private equity funds charging alpha fees for leveraged beta to please subscribe to my blog and/ or donate any amount via PayPal on the top right-hand side under my picture.

And if you vehemently disagree with me, no problem, pay for the privilege of doing so and I have no issue publishing your thoughts. One thing I can't stand however is whiners who attack me via email but have never contributed a dime to my blog (even though they read it religiously).

Also, I don't need people telling me how good my blog is, I know it's good, the statistics are public, the who's who of the institutional world reads it, but I'm still the Rodney Dangerfield of pensions.

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